Last week I wrote about the relationship between innovation and regulation in communications. I identified six areas of that relationship which I said I’d write about over the next few months (along with other issues). First up, this week and next, is competition. This week some history and ‘points of principle’; next week, some implications for today/tomorrow. (The history, of course, must necessarily be simplified. I’ve aimed to give the gist.)
Once upon a time there were monopolies
So what were telecommunications like when I first worked on them in the early ‘80s? There were only landlines then, and not so many of them (less than one per hundred people in around a quarter of the world’s countries). The Internet was in its infancy, known only to a few.
And almost everywhere, telecommunications were run by state monopolies. One organisation – almost everywhere a government department – ran the network, provided the service (really, only one), sold telephones and installed them in your home and office. This is nothing like how telecoms is in almost any country now.
Telecoms, almost everywhere, were seen until the ‘80s as natural monopolies. The costs of building networks were so high and user numbers were so low that it was thought impossible for two competing networks to recover their investment costs. Reinforcing this: network effects, encapsulated in what’s known as Metcalfe’s Law – the value of a network to its users is much greater when they can use it to connect with many people rather than with few, so large networks will tend to drive out small. (The effect of this can also be seen in social media today.)
So what changed?
Two things changed this back then. (Bear with me. This history’s still relevant today.)
First, technology and markets. Innovation was accelerating. Digital networks – then just coming in – were cheaper to run once initial investment in them had been made. More people signed up for subscriptions as prosperity grew and prices fell. New ‘value-added’ services became available. And so the balance between capital costs and revenue returns became more favourable. That monopoly began to look less natural.
Second, politics and policy. Privatisation (handing state-owned enterprises to the private sector) and liberalisation (making them competitive) were keynote policies of the Thatcher government in Britain, applied first in telecoms and then in many other sectors. That experiment was followed over time in the rest of western, then in eastern Europe. Privatisation and liberalisation became core elements of the ‘Washington Consensus’ of economic policy reforms that the World Bank and International Monetary Fund required of developing countries in the 1990s.
And so it was that competitive private sectors replaced state-run monopolies as the norm in telecoms. This matters now because the process by which it happened influenced its outcomes, and still does – an issue I raised in another recent post and will return to.
Why competition, though?
Before describing how this change was made, it’s worth recalling why proponents sought it.
Competition was the norm in most other economic sectors in market economies (though not, of course, in communist countries which were then numerous), from hairdressing, to petroleum, to food production/distribution. State monopolies were found only in public services, often called utilities, like water, electricity, transport and communications. They were anomalies to competition which had been justified by natural monopoly and the desire to prioritise public service over profit.
Those who sought to privatise and liberalise used two arguments.
First, they said, state monopolies were inefficient and unresponsive to their users. People routinely waited months or years to get a telephone installed. This was partly due to lack of funds. Privatisation would inject new capital into the sector and release public money to be spent on other things, like health and education.
Second, they argued, competition was inherently preferable to monopoly because competing firms would offer lower prices and better quality of service in order to win market share and so maximise profitability. That in turn would mean they would invest in innovation (to make cheapness and quality more profitable) and quality of service (to win customers’ brand loyalty).
These arguments were applied across public utilities. They were opposed (and still are) by many people who prioritise public service values and outcomes over commercial interest – not just politicians and trades unions, but also development and civil society organisations, and also voters/citizens. That opposition’s strongest over water.
But it’s very limited where communications are concerned. The large majority of civil society organisations that might oppose it elsewhere support competition in communications. For this I would suggest three reasons: it’s been successful facilitating access in ways that aren’t evident in other public services; it’s associated with diversity in the media and so with freedom of expression; and it’s been a core value of the Internet.
Market dominance
Competition to sell goods and services arises naturally in most cases. Natural monopolies are relatively rare. But perfect competition’s never found. There are always different factors to limit it, from economies of scale to market size. As businesses compete for market share, there’s constant tension between greater diversity and market dominance.
That dominance is difficult to define or calculate. Market share’s a decent, not a perfect proxy. What matters is whether any single business is able to determine on its own what happens within the market as a whole. Four examples:
- Can it, by cutting its own prices, make its competitors unprofitable or drive them out of business?
- Does it abuse its dominance, like a monopoly, to deny consumers the benefits of competition?
- Does it use its dominance in one market – say, mobile telephony – to gain market share in others where it isn’t dominant – say, mobile money?
- Does it buy up potential competitors before they have a chance to threaten its existing market power?
Market economies (like those that sought to privatise and liberalise their telecoms) typically have competition laws whose purpose is to maintain competition, ensure that consumers reap the benefits, and prevent any one competitor becoming too dominant in any market. (America’s anti-trust laws fall into this category.)
The dawn of (telecoms-specific) regulation
They’re not enough, though, when governments are trying to turn monopolies into competitors. When governments liberalised telecoms, they faced two problems.
First, liberalisation doesn't automatically lead to competition. ‘Incumbent’ network operators started with total market dominance (100% of market share). They also benefited from network effects. They could, for example, maintain their dominance by refusing to interconnect their customers with those of other networks.
Second, successful new businesses required significant numbers of customers to recover their investment costs. It was assumed that there'd be just a few competing networks (an oligopoly). And telecoms relies on scarce resources, including spectrum. It was assumed this too would limit numbers of competitors, not least in the (then) new market for mobile telecoms.
Governments responded to this by creating separate, independent regulators for telecommunications. The purpose of these regulators wasn’t to maintain competition in existing markets, prevent market dominance or mitigate its impact (like ordinary competition law) – but to create competition where it did not exist, to break existing market dominance.
This meant that, instead of maintaining a ‘level playing field’ between competitors, which is the goal in competition law, they had to tilt the playing field in favour of new entrants. One of the ways they did this was by requiring networks with market dominance to interconnect their networks with those of market entrants on equal terms (in cost and quality). Another was to prevent them leveraging their position in established markets (such as fixed telephony) to gain advantage in emerging ones (like mobile phones and cable television).
So why’s this relevant today?
The new communications regulators of the 1980s/90s sought to establish competition where there had been none. The regulations that they made to do this shaped the markets that evolved, and have had lasting influence on market evolution ever since. I’ll make two points arising from this, which I’ll explore next week.
The first concerns what happened as these markets became more competitive. In theory, the new regulators were supposed to shift from independent regulation – their much more powerful role creating competition – to normal competition law in which they'd just maintain it. But many markets haven’t become all that competitive. And many regulators have been slow to shed powers that were no longer necessary. Their regulations are still shaping communications markets, sometimes with more attention to what used to be than what’s to come.
The second concerns today’s very different communications markets and the market dominance that has arisen in new market areas, such as social media, search and online retail. What are the similarities and the differences between them and the dominant networks of the past? And what do those similarities and differences imply for the relationship between regulation and innovation?
Next week: part two – what’s happening today?
Image credit: Diagram showing the network effect in a few simple phone networks. Lines represent potential calls between phones. By Nathan Wood on Wikimedia Commons.